1. Money as a Medium of Exchange
Meaning of Money
Money is anything that is generally accepted as a means of payment for buying goods and services.
In earlier times, people mainly used the barter system, in which goods were exchanged directly for other goods.
Barter System
Under the barter system, one person exchanges one good or service for another.
Example:
A farmer has wheat but needs shoes. A shoemaker has shoes but needs wheat. If both agree to exchange wheat for shoes, the transaction can take place.
Problem of Double Coincidence of Wants
The major problem with barter is the double coincidence of wants.
It means that both persons must want what the other person has.
For example:
- A farmer wants shoes.
- A shoemaker wants wheat.
- The exchange is possible only if the shoemaker wants wheat at that particular time.
If the shoemaker does not need wheat, the exchange cannot easily take place.
Money Solves This Problem
Money acts as a medium of exchange.
The farmer can sell wheat for money and then use that money to buy shoes.
Thus:
Goods → Money → Goods
Instead of directly exchanging goods, people use money as an intermediary.
Example
Suppose Ravi sells vegetables worth ₹500. He receives ₹500 in cash. He can use the same ₹500 to buy books, clothes or food.
Therefore, money makes buying and selling easier and faster.
2. Modern Forms of Money
The forms of money used today are different from the goods used as money in ancient times.
Modern money mainly includes:
- Currency
- Bank deposits
Currency
Currency consists of paper notes and coins.
In India, currency notes are issued by the Reserve Bank of India, while coins are issued by the Government of India.
Currency is accepted as a medium of exchange because people have confidence that others will accept it in payment.
Why Do People Accept Currency?
People accept currency because:
- It is legally recognised as money.
- It is widely accepted.
- It is convenient to carry.
- It can be used to buy goods and services.
- Its value is generally accepted by people.
Example
If you purchase a school bag for ₹1,000, the shopkeeper accepts ₹1,000 because he knows that he can use that money to purchase other goods or services.
3. Currency and Bank Deposits
Money today is not limited to cash in our hands.
A large part of modern money exists as deposits in banks.
Bank Deposits
People keep their money in bank accounts instead of keeping all their money at home.
The money deposited in a bank account can generally be withdrawn when required.
Why Are Bank Deposits Considered Money?
Bank deposits can be used to make payments.
People can:
- withdraw cash,
- issue cheques,
- use debit cards,
- make electronic payments,
- transfer money to another bank account.
Therefore, bank deposits are an important form of money.
Example
Suppose Neha has ₹20,000 in her bank account. She does not need to withdraw all the money as cash. She can pay ₹5,000 to a shopkeeper through a digital bank transfer.
Thus, her bank deposit functions as money.
4. Demand Deposits and Cheques
Demand Deposits
Deposits in a bank account that can be withdrawn on demand are called demand deposits.
People can use these deposits whenever they need money.
Demand deposits have an important role because they can be used directly for making payments.
Cheques
A cheque is a written instruction to a bank to pay a specified amount from one person’s bank account to another person or institution.
How Does a Cheque Work?
Suppose Aman buys a bicycle for ₹8,000.
Instead of paying ₹8,000 in cash, Aman can give the shopkeeper a cheque for ₹8,000.
The shopkeeper deposits the cheque into his bank account. The banks then transfer the required amount from Aman’s account to the shopkeeper’s account.
Advantages
Cheques:
- reduce the need to carry large amounts of cash,
- provide a convenient method of payment,
- connect different bank accounts,
- make transactions easier.
Example
A student pays school fees through an online bank transfer from the parent’s bank account. No physical cash changes hands, but the payment is completed.
5. Loan Activities of Banks
Banks perform two major functions:
- Accept deposits
- Give loans
People deposit their savings in banks. Banks use a major portion of these deposits to provide loans to individuals and businesses.
How Banks Use Deposits
Suppose a bank receives deposits of ₹10 lakh from different customers.
The bank keeps a small portion as cash or reserves to meet withdrawal requirements and lends the remaining available funds to borrowers.
The borrowers use these loans for different purposes.
Uses of Bank Loans
Loans may be used for:
- starting a business,
- purchasing machinery,
- agriculture,
- education,
- housing,
- buying vehicles,
- meeting other financial needs.
How Do Banks Earn?
Banks charge interest on loans.
The interest received from borrowers is an important source of income for banks.
Example
A bank gives a business owner a loan of ₹5 lakh at an agreed interest rate. The business owner uses the money to purchase machinery and repays the loan with interest over time.
6. Credit and Its Importance
Meaning of Credit
Credit refers to an arrangement in which a person receives money, goods or services now and promises to repay the amount later, usually with interest.
Why Is Credit Important?
Credit can help people:
- start businesses,
- purchase equipment,
- invest in agriculture,
- pay for education,
- purchase houses,
- manage temporary financial difficulties.
Credit Can Have Positive Effects
Credit can increase production and income when it is used for productive purposes.
Example
A farmer borrows ₹50,000 to buy seeds, fertilisers and irrigation equipment. The farmer produces a larger crop and earns enough income to repay the loan.
Here, credit helps increase production and income.
Credit Can Also Create Problems
Credit is not always beneficial.
If the borrower cannot repay the loan, he or she may face financial difficulties.
This situation can lead to a debt trap.
Example
A farmer takes a loan for cultivation. Due to crop failure, the farmer earns very little. If the farmer cannot repay the loan, the debt may continue to increase.
Therefore, credit can be both helpful and risky, depending on the terms and the borrower’s ability to repay.
7. Terms of Credit
The conditions under which a lender gives a loan are called the terms of credit.
Important terms include:
1. Interest Rate
It is the amount charged by the lender for providing a loan.
For example, if a person borrows ₹10,000 at 10% annual interest, the interest for one year would be ₹1,000, subject to the agreed repayment terms.
2. Collateral
Collateral is an asset that a borrower offers as security against a loan.
It may include:
- land,
- house,
- vehicle,
- livestock,
- bank deposits or other acceptable assets.
If the borrower fails to repay the loan according to the agreement, the lender may have rights over the collateral as provided by the loan contract.
3. Documentation
Banks may require documents such as:
- identity proof,
- address proof,
- income-related documents,
- property documents, where applicable.
4. Mode of Repayment
The borrower and lender agree on how the loan will be repaid.
Repayment may be made through:
- instalments,
- monthly payments,
- a lump-sum payment,
- other agreed methods.
5. Duration of Loan
The loan agreement also specifies the period within which the loan must be repaid.
Example
Two people may need ₹1 lakh each, but they may receive loans on different terms because their income, collateral, repayment ability and loan purpose are different.
Thus, terms of credit can differ from borrower to borrower.
8. Formal Sources of Credit
Formal sources of credit are credit institutions that operate within a recognised regulatory framework.
Important formal sources include:
- Commercial banks
- Cooperative societies
Banks
Banks provide loans for:
- agriculture,
- businesses,
- education,
- housing,
- personal requirements and other purposes.
Cooperative Societies
Cooperative societies can provide credit to their members, particularly in rural areas.
Role of RBI
The Reserve Bank of India (RBI) supervises and regulates banks in India.
The RBI:
- monitors the functioning of banks,
- lays down certain regulatory requirements,
- helps ensure that banks follow established rules,
- works to maintain stability and confidence in the banking system.
Why Are Formal Sources Important?
Formal credit generally has more transparent terms and is subject to regulatory oversight.
Example
A small business owner may obtain a business loan from a bank at an agreed interest rate and repay it through scheduled instalments.
9. Informal Sources of Credit
Informal sources are lenders or arrangements that are generally outside the formal banking system.
Important informal sources include:
- Moneylenders
- Traders
- Employers
- Relatives
- Friends
Moneylenders
Moneylenders may provide loans quickly, sometimes with limited documentation.
However, their interest rates and other conditions can vary considerably.
Traders
A trader may provide credit to a farmer and later purchase the farmer’s produce.
Employers
An employer may give an advance to a worker, which may later be recovered from wages.
Relatives and Friends
People may borrow money from family members or friends, often without formal procedures.
Problems with Informal Credit
Informal loans can sometimes involve:
- high interest rates,
- unclear conditions,
- exploitation,
- difficult repayment arrangements.
Example
A farmer urgently needs money for medical treatment and borrows from a moneylender without comparing alternatives. If the interest rate is very high, repayment may become difficult.
10. Formal vs Informal Sources of Credit
| Basis | Formal Sources | Informal Sources |
| Examples | Banks, cooperative societies | Moneylenders, traders, relatives |
| Regulation | Subject to regulatory framework | Generally not regulated like banks |
| Interest rate | Generally more transparent | May vary and can be very high |
| Documentation | Usually required | Often limited or flexible |
| Written agreement | Generally present | May or may not be present |
| Borrower protection | Relatively stronger | Can be weaker |
| Transparency | Generally higher | Can be lower |
| Risk of exploitation | Generally lower | Can be higher |
Why Should Formal Credit Be Expanded?
Many poor households still depend on informal lenders because formal credit may not always be easily accessible.
Expanding affordable formal credit can:
- reduce dependence on moneylenders,
- lower borrowing costs,
- support productive activities,
- improve financial security,
- encourage economic development.
Example
If a farmer can obtain an affordable bank loan instead of borrowing from a moneylender at a very high interest rate, the farmer may have a better chance of repaying the loan and retaining more of the income from the crop.
11. Credit in Rural Areas and Debt Trap
Credit is particularly important in rural areas because farmers and rural workers often need money before they receive income.
Why Do Farmers Need Credit?
Farmers may need loans for:
- seeds,
- fertilisers,
- pesticides,
- irrigation,
- machinery,
- livestock,
- agricultural labour.
The Problem of Crop Failure
Agriculture is affected by factors such as:
- drought,
- excessive rainfall,
- pests,
- diseases,
- falling crop prices.
If a crop fails, the farmer may not earn enough to repay the loan.
Debt Trap
A debt trap occurs when a borrower becomes unable to repay a loan and may need to borrow again to meet existing obligations.
Example
Suppose a farmer borrows ₹60,000 to cultivate cotton. Due to unexpected crop damage, the farmer earns only ₹30,000. The farmer cannot repay the entire loan and may need another loan to meet the outstanding obligation.
This can create a cycle of increasing debt.
Important Point
Credit is not automatically harmful. The outcome depends on:
Purpose of borrowing + cost of credit + income generated + ability to repay
12. Self-Help Groups (SHGs) and Affordable Credit
Meaning of Self-Help Groups
A Self-Help Group (SHG) is a small group of people, often from similar socio-economic backgrounds, who come together to save regularly and provide small loans to members.
SHGs are especially important for improving access to credit for poor households and women.
How Does an SHG Work?
Members:
- Form a group.
- Save a small amount regularly.
- Create a common fund.
- Provide small loans to members.
- Charge an agreed interest rate.
- Maintain records of savings and loans.
- May later obtain loans from banks as a group.
Benefits of SHGs
SHGs can:
- provide access to small loans,
- reduce dependence on moneylenders,
- encourage regular saving,
- support small businesses,
- help members deal with emergencies,
- improve financial decision-making,
- strengthen women’s economic participation.
Example
Suppose 15 women form an SHG. Each woman saves ₹100 every month.
Monthly group saving:
15 × ₹100 = ₹1,500
The group can use its accumulated savings to provide small loans to members for activities such as buying raw materials, purchasing livestock or starting a small business.
SHGs and Women Empowerment
SHGs can help women become more involved in:
- financial decisions,
- income-generating activities,
- household economic decisions,
- small businesses,
- community activities.
Thus, SHGs can contribute not only to financial inclusion but also to social and economic empowerment.
Quick Chapter Revision
| Topic | Main Idea |
| 1. Money as Medium of Exchange | Money solves the problem of barter |
| 2. Modern Forms of Money | Currency and bank deposits are modern forms of money |
| 3. Currency and Bank Deposits | Bank deposits can be used for payments |
| 4. Demand Deposits and Cheques | Demand deposits can be withdrawn and used for transactions |
| 5. Loan Activities of Banks | Banks accept deposits and provide loans |
| 6. Credit and Its Importance | Credit can support production and income |
| 7. Terms of Credit | Interest, collateral, documents, repayment and duration |
| 8. Formal Sources | Banks and cooperatives provide regulated/formal credit |
| 9. Informal Sources | Moneylenders, traders, employers, relatives and friends |
| 10. Formal vs Informal | Formal credit generally has greater regulation and transparency |
| 11. Rural Credit and Debt Trap | Crop failure and costly credit can create repayment problems |
| 12. SHGs | Savings-based groups improve access to small and affordable credit |